In-Service 401(k) Rollover – What it is and How it Works

You might have heard of a 401(k) rollover if you’ve ever changed jobs and wanted to bring your retirement fund with you. One option, in that scenario, is to roll over your 401(k) into an IRA account, which may give you more control over your investment options and strategy.

But what happens if you want access to the benefits of an IRA using the funds from your 401(k) but haven’t changed jobs? For those individuals who are looking to roll over their 401(k) into an IRA while at the job that is sponsoring their 401(k) plan, they can consider an in-service 401(k).

This article will explore what an in-service 401(k) rollover is, how it works, and its benefits and drawbacks.

What is an In-Service 401(k) Rollover?

Employees with an employer-sponsored retirement plan — like a 401(k) — sometimes have the option to roll over their account into an IRA (Individual Retirement Account) without changing jobs. This is ideal for accountholders who are seeking the flexible nature of an IRA when it comes to retirement planning, and want to access:

1. A potentially cheaper retirement plan via an IRA
2. A greater variety of investment options
3. Increased control over their retirement savings strategy

When executing an in-service 401(k) rollover to a traditional IRA, the IRS does not see the transaction as a taxable distribution. Therefore the process is tax-free, as there are no withdrawals.

But if you want to roll over your pre-tax retirement account to a Roth IRA, you’ll have to pay taxes since a Roth IRA is a post-tax retirement savings account. You can roll an after-tax Roth 401(k) to a Roth IRA without any concern for taxes or early withdrawal penalties.

Remember that IRAs and 401(k)s are different account types and are subject to different contribution limits, required minimum distribution (RMD) rules in retirement, and loan options.

If, for example, you’re an employee at your company (which is the current sponsor of your 401(k) plan) and you want to roll over the funds into an IRA, the in-service 401(k) rollover gives you the option to do so without changing jobs.

Benefits and Drawbacks of In-Service Rollovers

Completing an in-service rollover has some potential benefits for investors and some drawbacks. It’s smart to consider both sides when deciding if it’s the right choice for your retirement savings. Let’s explore the pros and cons.

Benefits of an In-Service 401(k) Rollover

As we mentioned earlier, there are three main reasons why an account holder may choose an in-service rollover. Those reasons are connected with the primary benefits, which include:

• More comprehensive investment options: Since 401(k)s are employer-sponsored and accommodate a broad group of participants, they offer a limited range of mutual funds as compared to the options available on the market. IRAs can offer more comprehensive investment choices, and some custodians allow individual investors to select every investment within their IRA portfolio. There are numerous types of IRA accounts with various tax implications, like the traditional IRA or the Roth IRA. There are also self-directed IRAs (SDIRAs), which allow you to invest in non-traditional assets like precious metals or real estate.

• Possibility of lower fees: Many 401(k) custodians charge excessive fees, which can reduce your take-home investment returns. Some IRAs offer lower administrative fees, but you’ll need to conduct thorough research before you make a change. It’s still possible for IRAs to have even higher fees, as we’ll discuss below.

• More control: Because of the broader investment options available, and your ability to pick your own platform, IRAs can give investors more control than they would otherwise have with a run-of-the-mill 401(k).

Drawbacks of an in-service rollover

Along with the benefits, there are many risks involved when you choose an in-service rollover. Some of the drawbacks of this transaction include:

• Possibility of higher fees: As mentioned above, some accountholders might want to move to an IRA to avoid the high fees associated with their 401(k) account. But rarely, some IRAs may have even higher fees — these can include management and/or advisory fees, trading commissions, and more. Specialty SDIRAs are known for having high fees because they have unusual asset classes and, in certain cases, their underlying investments might have limited liquidity.

• No option to take a loan: When you have a 401(k), you may be able to take out a loan against your account balance — this depends on your employer. If you’re considering rolling over your 401(k) into an IRA, be sure that you’re comfortable with forgoing the loan option.

• No option to start withdrawal at 55: Qualified distributions for IRAs and 401(k)s both begin at age 59 1/2. However, with a 401(k), you can take penalty-free withdrawals starting at age 55, assuming you meet all necessary criteria. This is not available within an IRA, and early distributions will be subject to taxes, penalties, and fees.

• Delay in resuming participation: Even if your provider allows for in-service 401(k) rollovers, they may stipulate that you wait a certain period of time before resuming your contributions to your employer-sponsored 401(k) after completing the rollover.

How Does an In-Service 401(k) Rollover Work?

Not all plans offer the in-service rollover option, so double-check with your administrator or plan sponsor before you pursue this route. If they offer it, there are two ways to complete your in-service rollover, directly or indirectly, like any 401(k) rollover.

With a direct rollover, the 401(k) custodian transfers the funds straight to the new IRA account, and the money never touches your hands as an account holder. They can also write a check to the new IRA but not to you.

When you choose an indirect rollover, you withdraw the money from your 401(k) and re-deposit into a new retirement account. There are key rules to keep in mind when you are completing an indirect rollover — this makes one riskier than a direct rollover:

• You must adhere to the IRS 60-day rollover rule, which states that any funds you withdraw need to be re-deposited in a retirement account within a 60-day timeframe to avoid tax penalties and fees.
• The IRS views the withdrawal as a distribution, and if you don’t re-deposit the funds in an IRA within 60 days, you will be subject to a 10% early withdrawal penalty plus income tax on the gross amount of the distribution (before any tax withholdings).

More limitations apply to in-service 401(k) rollovers, including the age of the account holder and the age of the 401(k) account. Be sure to check your company’s 401(k) summary plan document before proceeding.

Am I Eligible for an In-Service 401(k) Rollover?

Not all employer plans allow in-service rollovers. It depends on the terms and policies associated with the plan. You should check with your plan administrator, and more specifically, your 401(k) summary plan document, to learn your specific guidelines. If your plan is eligible, then you, as the account holder, may have to meet specific eligibility criteria, including any of the following:

• You must be at least 59.5 years of age.
• You may need to prove you have been disabled.
• The 401(k) account must be at least 2-5 years old.
• The account must have been terminated.

Additionally, some accounts that do permit in-service rollovers will have rules around the time you need to wait to resume your 401(k) contributions.

Alternative Rollover Options for Your 401(k)

If your plan provider doesn’t offer the option to conduct an in-service rollover, or this option doesn’t align with your needs, there are many other ways you can handle your retirement plan.

1. You can keep your 401(k) until you change jobs, at which point you can roll it over into an IRA when you leave your current employer.
2. You can keep your account in a 401(k) and roll it over into your new employer’s 401(k) plan when you change jobs. Each plan provider has different fees, portfolio structures, and policies. Your new employer’s plan may even allow in-service rollovers when your former employer didn’t.
3. You can roll over your 401(k) into an annuity with tax-deferred status.

FAQs

What is the difference between in-service rollover and direct rollover?

These are two related subjects, not opposite concepts. An in-service rollover allows you to transfer your retirement savings into an IRA without changing jobs. You can complete this through a direct rollover, which means the money moves straight from your existing retirement account to your new provider.

How often can you do an in-service rollover from your 401(k)?

Please refer to your company’s 401(k) summary plan document to confirm the frequency with which you can perform in-service rollovers.

Are in-service withdrawals eligible for rollover?

Generally, your in-service distribution can be rolled over into an IRA. The same fees and tax withholdings apply as if this was completed via an indirect rollover.

Need Help Managing an In-Service 401(k) Rollover?

Completing an in-service 401(k) rollover can help you access the benefits of an IRA without changing jobs. Depending on the financial institution you choose for your IRA, you may be able to get an account with lower fees, gain more investment options, and increase control over your retirement savings.

There are also potential challenges associated with an in-service rollover, including age limits, participation limits, loan restrictions, and the potential for higher fees.

Not every plan administrator offers the in-service option, so you should consider working with a qualified financial planner or financial advisor before making a decision.

When managing your retirement accounts, working with a trusted partner who can help with financial planning, personal finance decisions, and regulatory compliance is essential.

Capitalize offers seamless 401(k) rollover services to help you organize your retirement savings, plan for the future, and manage your retirement accounts from previous and current jobs.

Explore our services to see how we can help you take control of your financial future.